I don't get this

[Esuric]

This comes from a drudgereport article about the next potential round of QE from the FED. It says,

Emerging economies have their own concerns. The weak dollar has sent investors searching for fatter returns in faster-growing emerging markets, driving up inflation and asset prices. South African Finance Minister Pravin Gordhan said this forces emerging markets to tighten monetary and fiscal policy sooner than they would like.

This should not cause inflation in foreign markets, in fact, capital flight and the dollar carry trade should cause foreign currencies to appreciate (relative to the dollar). Tightening monetary policy and elevating interest rates would only perpetuate and increase their rate of deflation and capital flight/foreign investment into their economy. I would think that governments, rather than tightening their monetary policies, in the face of significant dollar depreciation, have every incentive in the world to only devalue their own currencies and stimulate exports (especially since most of the emerging markets rely on “export-led growth”).

What am I missing, or is this guy just wrong?

[Merlin]

Well, I see two possibilities here.

First, if there is a formal or informal peg between the other countries and the dollar, a dollar inflation wills end investment money into these countries, making their currencies appreciate and forcing their governments to inflate to keep the peg.

Or, absent pegs, this strange idea that depreciation somehow helps exports might be the reason, as you hint. But absent an other action besides the dollar inflating, I really do not see how that could be the case.

[Smiling_Dave]

A weak dollar means, by definition, that foreign currencies have appreciated relative to it.

The question of what a country should do when the dollar gets weak is an interesting one. We find China stubbornly resisting attempts to make their money worth more dollars. And this seems to be the path all countries are following [or would like to follow], devaluing their own currencies to keep at the same level that they were with respect to the dollar.

And the rationale of course is to stimulate exports. But it is just another of the economic absurdities flying around.

What is the purpose of exports? To get foreign money. And what is the purpose of getting foreign money? To buy foreign stuff.

OK, let’s look at what happens in a devaluation, from all sides.

Say that the Confederate States of America has one Confederate Dollar, tradable for one US Dollar. So if they make something that costs them one Confederate dollar and sell it for one US dollar, they can buy whatever one US dollar can buy, say a copy of the Wall Street Journal.

Now say the US dollar devaluates and is worth half a Confederate Dollar. Then Southerners can take the same old Confederate dollar and get double, two Wall Street Journals. So they win. In fact anyone in the South can now buy double what he used to from the US. Walmart South stores will open, selling cheap US goods in the South. Everyones standard of living rises in the South.

Of course there is a little catch. Of the hundreds of millions of Southerners who gain tremendously from the US dollar devaluating, there is a small group who might lose. The Southern exporters. Their exports to the US will be more expensive for US citizens to buy, so they will probably sell less in the US. The doubling of their profits [two Wall Street Journals instead of one] might not be enough to offset the lower amount of sales.

The US citizens lose big time, because they can no longer afford Southern products.

Just to complete the picture, US exporters will sell more in the South, so it looks like they are gaining. But what will they get in return for the thing it cost them a US dollar to make? Half a Confederate dollar. And half a Confederate dollar still only buys what it used to of Southern products. Meaning the US exporters sold more, but got paid less.

Bottom line: If a country devalues its currency to “stimulate exports”, all its people lose big time. The whole economy suffers; the standard of living drops. Even the exporters may lose since they are getting less per item than they used to. If they want to increase sales by selling cheaper, they could just drop their prices without screwing over the whole country with a devaluation.

As to the claim that foreign investments will drive up inflation, we Austrians know that inflation is by definition more local money printed. So that foreign investments have nothing to do with inflation. As for driving up asset prices, that sounds right. More demand [coming from foreigners] raises prices.

So that indeed the local govt wont be able to drive up prices like it always does by printing money, because added to the price rise already caused by increased foreign demand, it may be more than people can handle. But that has nothing to do with devaluating their currency, which is always bad for the people.

[Merlin]

@Smiling Dave

Say that the Confederate States of America has one Confederate Dollar, tradable for one US Dollar. So if they make something that costs them one Confederate dollar and sell it for one US dollar, they can buy whatever one US dollar can buy, say a copy of the Wall Street Journal.

Now say the US dollar devaluates and is worth half a Confederate Dollar. Then Southerners can take the same old Confederate dollar and get double, two Wall Street Journals. So they win. In fact anyone in the South can now buy double what he used to from the US. Walmart South stores will open, selling cheap US goods in the South. Everyones standard of living rises in the South.

You concede far too much. Not one southerner would gain form the US dollar devaluation. Why? If the north has inflated so much that the value of its currency is cut in half, two things happen: 1) as you point out, in a flexible exchange rate system, the confederate dollar would trade against two US dollars and 2) prices in the north would double! In the net no one gain or loose, not importers, not exporters. Whatever boost of northern export might arise, it only happens because normally exchange rates change faster than prices. But within a short time the increased demand form the south will drive prices to their proper height.

After all, no new goods have been produced, and no preferences have changed, hence no change in consumption volume and patterns will ensue.

This is what I mean when I say that the idea that devaluation somehow stimulates exports, which many Austrian economists endorse, is meaningless to me (that is, in a freely fluctuating exchange rate).

[Esuric]

1. as you point out, in a flexible exchange rate system, the confederate dollar would trade against two US dollars and 2) prices in the north would double! In the net no one gain or loose, not importers, not exporters. Whatever boost of northern export might arise, it only happens because normally exchange rates change faster than prices. But within a short time the increased demand form the south will drive prices to their proper height.

After all, no new goods have been produced, and no preferences have changed, hence no change in consumption volume and patterns will ensue.

You’ve identified the first problem with your analysis, namely that prices don’t automatically adjust (there’s a lag; the j-curve). But what you’re forgetting is that a 50% increase in the total supply of money, for example, does not necessarily yield 50% general price inflation (in fact, we shouldn’t expect this at all). The inflation may be concealed by general productivity gains (natural) and by the increase in total production and investment (in the short-run) brought about by monetary expansion and lower interest rates (entirely unnatural).

The major problem with this type of mercantilism and with our current system in general (systems with freely fluctuating national currencies), is that that currency devaluation attempts to create illusory comparative advantages which yield all sort of structural asymmetries and capital flight, which only perpetuates the problem (run away spiraling deflation and/or inflation; there’s no natural self-correcting mechanism). This is impossible under an international gold standard (price species flow mechanism).

This is a major difference between the Austrians and the mainstream.

[Merlin]

Sure, you’re right to point out that money is not neutral, but whatever net imbalances are left are caused by inflation as such, not by devaluation of the exchange rate. The rate, as such, can boost no exports, and only the fact that money is not neutral and that some markets, namely the FOREX market, respond faster than others might, in some cases, increase export for a while.